Note: I am not interested in discussing the proposed legislation in this article at all. I know pending or proposed legislation is not permissible to discuss.

Here is what I want to talk about; this snippet:

A billionaire can borrow against his stocks, art and real estate, and spend that borrowed money without paying tax. All he has to do is pay interest on the loan. When he dies, his heirs can sell the assets to pay off the debt. Under an existing rule known as the “step-up in basis,” no matter how much the assets have appreciated in value, no one will owe income tax on that gain. And the rest of his fortune goes to his heirs without anyone ever paying income taxes on the appreciation in the assets.

Can the rest of us mere moral bogleheads do the "step-up in basis" strategy too. Here is what I am asking. Suppose over a lifetime a work someone pays off their mortgage and accumulates say 2 million in savings held in Vanguard Total Stock Market. This hypothetically includes over 1.5 million in unrealized gains. Can this person take out a big reverse mortgage on their property, live the rest of their life on the reverse mortgage proceeds all the while paying the mortgage interest etc, and then pass on the 2 million minus debts tax free to their heirs because of the "step-up in basis" tax rule?

ProfessorX, The answer to your question is yes.. so long as the assets are in a taxable account. If you hold total stock market in a 401k or TIRA then you will be forced to take RMDs once you are of age. I suppose you could still borrow from those accounts but you will still be subject to RMD

Hint: you don't need to be a billionaire, but you do need to find a friendly banker willing to use your appreciated assets as collateral. Unless Mr. Banker has control over disposition and location of those assets (analogous to a margin account), Mr. Banker might have some 'splainin' to do should those assets go "poof", or meander to the Caymans.

If you're the type to take seriously your personal obligation to help others you can launder your giving through your taxable brokerage account and donate appreciated shares rather than earned income. Awesome way to always raise your cost basis while doing what you would anyway.

"Normal" people now permanently enjoy the 0% LTCG rate for the idle rich. A married couple with gross income up to about $100,000 is in the 0% LTCG bracket. No need to wait for the step up to liquidate appreciated stocks. Sell some every year and thumb your noses at the younger generation who still have to pay taxes.

This is a common technique for older people who have used up all of their assets other than highly appreciated securities, and whose living expenses exceed their income. If they don't want to sell highly appreciated securities, and want to preserve the basis step-up at death, they can borrow money, either by taking out a mortgage (either conventional or reverse), or by a margin loan against their securities. A margin loan is simpler than a mortgage.

There are some risks and tradeoffs. The interest they pay will generally not be deductible. If the securities decline in value, the leverage magnifies the loss. However, the loan is typically small in relation to the value of the securities, so this risk may be manageable.

At a 15% capital gains tax rate, some people will simply sell some securities and pay the capital gains tax. However, if you're in the AMT exemption phaseout, your marginal rate on capital gains, even in the 15% bracket, can be 22%. In addition, there can be state income taxes. Also, some people may be taxable at 20% rather than 15% on capital gains, and may be subject to the 3.8% Medicare tax on net investment income.

Another possibility is to contribute some appreciated securities to a charitable remainder trust. That has the effect of deferring the capital gains tax and spreading it out over a number of years rather than eliminating the tax. However, this technique has its costs, complexity and inflexibility.

The clients who have chosen the margin loan have generally been very elderly, with very highly appreciated securities, often with very low basis. The loan is typically small compared to the value of the securities, so that they're willing to accept the risk of a market decline.

bsteiner wrote:living expenses exceed their income15% capital gains tax rate --> gross income over about $100,000in the AMT exemption phaseout --> gross income over about $150,000some people may be taxable at 20% --> gross income over about $450,000may be subject to the 3.8% Medicare tax on net investment income --> gross income over about $250,000

Remember that if you're liquidating appreciated stocks, the basis portion doesn't count as income for tax purposes, but it's income for living expenses purposes. So you're talkng about really high living expenses here for a retired couple. Presumably the couple in question is massively wealthy and can have a significant amount in municipal bond funds, producing more tax-free income to cover these really high living expenses.

ProfessorX wrote:Suppose over a lifetime a work someone pays off their mortgage and accumulates say 2 million in savings held in Vanguard Total Stock Market. This hypothetically includes over 1.5 million in unrealized gains. Can this person take out a big reverse mortgage on their property, live the rest of their life on the reverse mortgage proceeds all the while paying the mortgage interest etc, and then pass on the 2 million minus debts tax free to their heirs because of the "step-up in basis" tax rule?

Hi ProfessorX, Interesting question. The answer is "Yes."

The proceeds of the reverse mortgage loan are not taxable. However, the interest on the reverse mortgage is not tax deductible until it is paid, which is generally after one dies. And then it's only deductible for the interest that applies to the 1st $100K of reverse mortgage debt. The reason for that $100K limitation is that the Internal Revenue Code treats reverse mortgage loans as a form of home equity equity loan. For more details see http://www.reversemortgage.net/is-rever ... eductible/ .

If one goes the broker margin loan route, the interest would not be tax deductible because the loan in this case would not be used to purchase securites or a home. Best, Neil

For what it's worth, this technique has long been popular with real estate investors... i.e., you buy a property for $1,000,000 or whatever... it appreciates to $2,000,000. You then go out and borrow against the appreciation.

I am sorry to have to report that this ends in much wailing and gnashing of teeth if you ever have to sell... if you have to sell, you've typically spent the cash and have no money to pay the taxes.